“The Overall Imbalance in the System is Lower”

THE QUESTION OF PROACTIVE BALANCING GROUP MANAGEMENT TO SUPPORT THE POWER GRID HAS BEEN A HOTLY DEBATED TOPIC IN GERMAN ELECTRICITY TRADING FOR YEARS. SHOULD BALANCING RESPONSIBLE PARTIES - AS IN MANY OTHER EUROPEAN COUNTRIES - ALSO BE ALLOWED TO SUPPORT THE GRID IN GERMANY THROUGH DELIBERATE IMBALANCES IN THEIR PORTFOLIOS OR NOT? FLEXPOWER DISCUSSED THE RESULTS OF A NEW STUDY ON THE SUBJECT WITH THE AUTHOR, PROF. DR. LION HIRTH OF NEON NEUE ENERGIEÖKONOMIK. BELOW YOU WILL FIND THE TRANSCRIPT OF THE WEBINAR, THE RECORDING OF WHICH YOU CAN ALSO WATCH ON YOUTUBE (IN GERMAN LANGUAGE). THE FOLLOWING TRANSCRIPT HAS BEEN EDITED FOR BETTER READABILITY AND IS A MACHINE TRANSLATION FROM GERMAN INTO ENGLISH.

What is Proactive Balancing Group Management?

Jan Aengenvoort

Hello Lion, NEON Neue Energieökonomik recently published a study on electricity trading in Germany. Can you briefly tell us about it? What was the main topic of the study?

Lion Hirth

Of course, and good morning from Berlin. Our study, which we conducted on behalf of several companies, dealt with the long-standing topic of balancing group management. I started working on this back in 2003 when I was at Vattenfall and have since written several projects and articles on the subject. The focus was on the question of what balancing responsible parties should pay attention to in their portfolio management, in their short-term asset dispatch and in their intraday trading.

More precisely, the question is whether they should focus exclusively on their own balancing group in order to keep it as balanced as possible (physical balancing group management) or whether they should also keep an eye on the system as a whole, in particular the imbalance price, which describes the scarcity in the system in real time. Should they try not only to aim for zero in their own balancing group, but also to stabilize the system as a whole, for example by taking a slight long position in their balancing group when the system is short of energy?

Jan Aengenvoort

That sounds complicated at first for non-experts in balancing group management. Let's dive deeper into your last sentence. If the system is short, as you just explained, they buy additional electricity, right? Can you explain this with a practical example? What impact would that have, and what happens to the purchased electricity that the balancing group manager might not need, and what does it look like on the seller side?

Lion Hirth

I'm looking out of the window here and see Reuter West, the coal-fired power plant in West Berlin, smoking. Imagine I am the owner and operator of this power plant in Berlin. I have planned to generate 500 MW of electricity in this hour and sell a quarter of it as MWh in the next quarter of an hour. So I operate my plant at 500 MW.

If everything goes as planned, my balancing group is balanced out and I do not receive or pay an imbalance price. Electricity is sold exclusively on the wholesale market. However, if I look at the system balance or the imbalance price and realize that there is a significant shortage of electricity in Germany (for example, due to unexpectedly less solar generation or a power plant outage), I can react on that.

Why should I do this? Because this shortage will be reflected in the imbalance price. This means that the price for the balancing group deviations will be higher than expected or higher than yesterday's spot price for that hour. In this case, I could start up an additional plant to produce more electricity than I sold. This leads to a surplus in the balancing group settlement, which is offset financially by the higher imbalance price.

But what happens with the surplus electricity in the grid, physically speaking? If the grid was previously short of energy, my actions have helped to stabilize the system and steer it towards a more balanced system. This means fewer frequency deviations, less activated control reserves by grid operators and fewer unplanned flows via the German interconnectors from abroad. This improves the operation of the electricity system and makes it more stable, simpler and safer.

What are the risks of Proactive Balancing Group Management?

Jan Aengenvoort

Not being a power trader myself but a layman, that sounds positive to me at first. But why is this topic so controversial? There must also be risks involved.

Lion Hirth

There are basically two philosophies: physical balancing of the balancing group versus system-oriented balancing of the balancing group. You can also look at it as an economic versus electrotechnical view. Economically, and I am an economist, this is basically simple. If prices are correct and the system is robust, companies will react to price changes. If there is a shortage of energy, they will produce more, and if there is a surplus, they will produce less. This makes sense and supports the system.

Jan Aengenvoort

And by price do you mean the imbalance price in this case?

Lion Hirth

Exactly. Whenever I say price without qualification, in today's session I mean the imbalance price, i.e. the price at which balancing group deviations are settled financially at the end.

But now there is another way of looking at it. And this is perhaps one that is now more natural for colleagues in system operations management. There's a bit of a perspective that says, market and trading all well and good, but at some point there has to be an end and then we take over. So we allow trading until, I don't know, five minutes before gate closure. But at that point, we want all balancing groups to be balanced and we don't want anyone messing around in the system, but from that moment on, the control reserve takes over, the sovereignty of system operation management applies and the TSOs in the dispatch centers want to know what is happening and operate the controllers themselves and rely on the tertiary reserve and the aFRR controller.

Jan Aengenvoort

Is it conceivable, now following this second line of thought, that traders systematically destabilize the system through this balancing energy mechanism, so to speak? That would be the worst-case scenario imaginable.

Lion Hirth

Exactly, and that's not just theoretical thinking, because we actually had three situations in June 2019 that weren't worst-case scenarios, but I would say they were close to a collision with the iceberg. In my opinion, that could have gone wrong. I think the situation is a good example of the dangers in the system. There is a danger in the system when information that is published, to which market participants, balancing responsible parties and traders react, is false or misleading.

For example, on June 12, 2019, in the situation that then became quite critical, there was a massive shortfall. We had a peak shortfall of up to 10 gigawatts in the balancing groups. 10 gigawatts is really, really a lot, and the (incorrectly) published values of the grid operators looked quite relaxed and indicated a much less unbalanced system and in some cases even a system in balance. This was an IT error somewhere in the system. If you want and need market reactions to information and this information is wrong, it is relatively obvious that the reactions will also lead in the undesired direction and in this case have not yet led to ruin, but then to a fairly critical situation.

This means, conversely, that you really have to think about robustness, IT security and redundancies in data publication. Just as we have in other systems, i.e. the aFRR activation or control reserve activation in general must also meet high IT requirements and this should also apply to the system-relevant real-time data.

And the second point is that if the information is correct but the incentives are wrong, then we will also get the wrong reaction. The imbalance price is subject to an extremely complex price formula. I believe that in the current version, this formula extends to over 15 pages of documents. And it wasn't that good in the past either. And if the price formula is not so good, then there can be situations where I am not financially rewarded in a shortage situation for feeding more into the system myself, i.e. for taking a long position it, for doing the right thing, but the opposite: I am financially rewarded for destabilizing the system because the imbalance price is relatively low. Relatively low always means in comparison to the current intraday price. In June 2019, for example, it was already a few hundred euros, so it was already relatively high. But if the intraday price is more like 1000 euros at that moment, then 400 euros is actually quite low and in such a situation the price provides the wrong incentive.

This means that we need a system that is robust in two respects. Firstly, in terms of information, including IT issues, and secondly, in terms of the pricing formula for the incentive mechanism.

And my last sentence on this, because I've talked so much about four years ago, a lot has happened since 2019 and I believe that we have a price formula for the imbalance price that is extremely robust. Our qualitative analyses also show this. The (price formula) always points in the right direction, so to speak, and you can say that both empirically and analytically.

How does Proactive Balancing Group Management work?

Jan Aengenvoort

Okay, back to the study you just mentioned yourself. You describe how this system-supporting balancing group management or "active balancing", as it is sometimes referred to, is already being practiced in Germany today - although the legal situation is unclear. How did you come up with that? How did you find that out?

Lion Hirth

Perhaps I will say two more sentences about the legal situation and then about our study and your question, even if it is a slight detour. The legal situation is such that there is a regulation under European law, which comes from the European Balancing Guideline and which says, I'll paraphrase briefly, that you can either set your own balancing group to zero and have it as a target function, so to speak, or that you can keep an eye on the system. This is a regulation, which means that it is directly effective and there is a legal opinion that every market participant can decide for themselves that they can either do one or the other. This would make system-supporting balancing group management possible without any problems. And the other legal opinion is that the German TSOs or another German player, such as the BNetzA, can decide this and then all German companies must comply. I'm not a lawyer, I can't decide that, but the BNetzA and grid operators have jointly drawn up the balancing group contract and there is a regulation on this, which states relatively clearly that balancing responsible parties do not have to do everything possible, everything humanly possible, but must reduce their own balancing group to zero within the bounds of what is reasonably feasible. So there is no provision for system-supporting balancing group management. This is not a law, but it is a contract that all market players in Germany sign.

Jan Aengenvoort

What I have always asked myself is, if that is the case that active balancing is not allowed, and this position is legitimate, of course, why is there this balancing energy mechanism that I can even earn money with? So why set this financial incentive?

Lion Hirth

That is a legitimate question.

Jan Aengenvoort

Or let me put it another way: Does this balancing energy mechanism or this price mechanism, this price incentive, have any other function than the one that is potentially not allowed?

Lion Hirth

I would say not really. Of course, you could say that, as we always say in political Berlin, it's the suspenders to the belt. So we ban something and, to be on the safe side, we add a price incentive so that companies that, for example, do poor balancing group management or make the system balance worse and worse through their trading feel not only, let's say, the legal sword hanging over them, but also the financial one. As an economist, I would say that you either think in terms of incentives or you think in terms of prohibitions. These are two different worlds. And I do see a bit of a question mark there.

And this is also the practice in reality: years ago, two or three years ago, we published a scientific study in which we used a complex statistical procedure, for the connoisseurs, with instrumental variables to estimate the demand curve, to show that the market reacts to the imbalance price. In this procedure, we only use public data for these studies, because we have never received data from balancing responsible parties, but have only ever used data from ENTSO-E Transparency and Network Transparency etc., and if you look at the data properly statistically, you can see that the market reacts to imbalance prices. And reacting to the price means nothing other than balancing group management that serves the system. I would say that this has been statistically established knowledge for several years now.

What are the Economic Effects of System-Supporting Balancing Group Management?

Jan Aengenvoort

Well, let's move away from the minutiae of day-to-day electricity trading and ask ourselves what the economic effects are of this active balancing that is apparently actually taking place? What effect does the whole thing have if we take another step back?

Lion Hirth

The immediate effect is, of course, that the overall imbalance in the system is lower. So in the previous example, instead of a shortage of 1,000 MW, we now only have a shortage of 900 MW if I produce 100 MW more electricity with my Reuter West power plant than I had sold before. And that means grid operators will then have to activate 100 MW less control reserve. FCR would not be activated anyway, but secondary and tertiary reserves, aFRR and mFRR, would be activated to reduce such imbalances. And if the imbalance is smaller, you have to activate less and then you have to pay less money for it. So it is a cost reduction. These cost reductions are in turn passed on to all market players via the imbalance price. This means that, in the end, all market players benefit from this, especially those who, because they are small or perhaps because they now have limited resources, were on the wrong side themselves; in other words, they have exacerbated the system balance, made it worse. These may be municipal utilities, distribution grid operators, small renewable energy traders or industrial consumers of electricity. They then benefit from lower imbalance costs.

Jan Aengenvoort

... because the imbalance price is the allocation of the balancing energy activation costs. That's why it lowers the costs...

Lion Hirth

Exactly, they are at least part of the equation. They used to be more closely linked. Now, for good reasons, they are no longer so closely linked. But basically, if the grid operators have significantly higher costs for control reserve activations, then the costs for balancing energy also increase and vice versa. And that affects us all. Although we are not balancing responsible parties ourselves, i.e. at home I mean in our private lives, we naturally also pay via the grid charges, because our distribution system operators are better or worse at balancing for us via balancing groups that result from our standard load profiles. And if the costs fall, then we all benefit privately through lower grid charges.

What Impact does System-Supporting Balancing Group Management have on the Tendered Quantities of Control Reserve?

Jan Aengenvoort

What indirect effect does this have on the tendered quantities of control reserve? We have now talked about the activated quantities of control reserves, but what about the tendered quantities of control reserves?

Lion Hirth

I would say that the connection is perhaps not so direct and clear, but can be qualified a little. It depends on how the transmission system operators define the volume that is put out to tender. One possibility would be to say that we think this system-supporting balancing is good, but we don't want to trust it and in the final instance we always want to have enough capacity, so we keep the same capacity as before. Then it would not be a deterioration, but also not an improvement from a cost perspective, because you would simply put exactly the same amount of reserves out to tender. Or you do what I understand the network operators do today, I don't know exactly. Basically, they look at how much control reserve was actually activated over the course of the last year, at similar times of the year and days of the week, and then apply a distribution function over it and thus dimension the balancing power and if you do this and overall less is activated, even at the edge of the distribution, where a lot of activation was necessary, if the situation there also improves through good behavior on the part of the balancing responsible parties, which is to be expected, then less control reserve would be required, less control reserve would be put out to tender and thus lower costs would be passed on, which incidentally would also be reflected in the grid fees that we all pay.

Jan Aengenvoort

You have now worded that as a conditional clause, and I know that the volumes of control reserve put out to tender have successively fallen over the last 10, 12, 13 years, in some cases massively. So do you see a direct correlation here or are there other reasons why the volumes put out to tender have actually fallen in Germany?

Lion Hirth

I would delete "in some cases" and emphasize "massively" instead. So one image I have in my head, which I always call the German control reserve paradox, is the comparison of renewable energies and the control reserve that has been put out to tender in Germany, let's say over the last 15 years.

In the last 15 years, and I have the figures in front of me right now, we have increased the installed capacity of wind and solar, which are the technologies that people are plausibly concerned about increasing the need for control reserve due to weather-related uncertainties, fivefold during this time. A massive increase from over 20 GW to around 130 GW at the beginning of last year. At that time, we would have thought ex ante, and that's not a subjunctive, because we even published a study over ten years ago where we said, hey, watch out, this is pretty dangerous, we'll certainly need a lot more control reserve and more control reserve means higher costs, more must-run capacity, lots of problems, a real problem for the energy transition. But no way, the control reserve required for the five-fold increase in wind and solar in Germany has fallen by half. That's crazy and when you show that to engineers at international conferences - I've really done it dozens of times - you see open mouths and that's simply not what a sensible electrical engineer or energy systems engineer would expect, because you would expect more wind, more fluctuations, means much more control reserve.

But you asked specifically whether this can be explained by the system-supporting balancing group management and, as a scientist, I have to say that it is difficult to provide a watertight "smoking gun" causal evidence. But of course you can consider what improvements have been made in the last 15 years. And of course a lot has happened with the grid operators: the grid control network was introduced, the international cooperation SRR, imbalance netting was introduced, now recently a slightly different topic, but as part of the improvements, Mari and Picasso, the international activation platforms, have been introduced. All correct, but of course a lot has also happened on the market. Quarter-hourly trading has been introduced, there has been a massive overall increase in intraday volumes and much better forecasting, data analysis and portfolio management at the balancing responsible parties. And why is that? Because the price incentives are working, of course. In other words, I am actually convinced that the driver behind these improvements on the market and among the traders was and is largely driven by the financial incentives.

And the incentives are both positive and negative. So in the negative sense that you get a bloody nose if you are unbalanced in the wrong direction and you want to avoid that, but also in the positive sense that it is financially worthwhile to be on the right side and that this leads to companies not only having an interest in forecasting their own portfolio, but also in forecasting the market as a whole and this has driven massive improvements, progress in forecasting quality overall.

Jan Aengenvoort

Okay, if we take this thought further, the next question for me is, of course, what do you think would happen if, from one day to the next, all balancing responsible parties, who today, as you said, "take the right side", were now only to close their own balancing group and no longer look at the system imbalance? What do you think would happen?

Lion Hirth

So I think it would be dubious to put a concrete figure on it, but I am convinced that if this were to happen overnight, and nobody does it from tomorrow onwards, there would then immediately be a massively higher activation of control reserves, which would also have to be reflected in a jump in capacity tenders, relatively quickly. I don't think anyone can say for sure whether this will be one, two or three gigawatts, or at least I can't say for sure based on public data. My feeling is that it's quite a lot. So my feeling would actually be that with the current amounts of control reserves, you would very quickly have a very massive operational problem if you were to force the market overnight or if the market were to stop its system-supporting behavior overnight, so to speak.

Jan Aengenvoort

Which is another idea when we think about control reserve, and you mentioned this at the beginning, it has the great advantage that it can be completely managed by a central authority, it can be deployed, it is completely predictable, it can be scaled and measured esaily. However, it naturally has a much shorter lead time for activation. If I now assume, as you found out in your study, that some market players are already supporting the system by buying, selling, whatever, before the transmission system operators start using control reserve , then they have more time to dispatch their power plant fleets, or am I being too short-sighted?

Lion Hirth

No, exactly. Perhaps two more sentences on the activation of control reserve and then the topic you mentioned.

Control reserve is very fast for good reasons. The aFRR basically has to be activated within five minutes via a ramp. The tertiary reserve, the mFRR, is a schedule product and is activated with a lead time of 7.5 minutes, I believe, before the quarter hour. This means, of course, that only plants that can do this are eligible to provide this service. In other words, both technically, which can handle the ramps, but also operationally, which can integrate the IT and which can always deliver full power within these few minutes in every situation.

What happens now, for example, in reality with wind and solar generation? What we have is that wind and solar generation still involves a degree of uncertainty on the time scale of a few minutes, but that over the course of time, let's say it's now half past 10, new weather forecasts have been coming in for delivery 10 to a quarter past 10 over the course of the last day and up until a few minutes ago. In other words, new models are coming in every minute from some forecaster or other. These models all have uncertainties, some of them are ensemble models, bandwidths so to speak, and the metrics for forecast uncertainty shift over time and get better and better and tighter, without going back to zero. What can happen now and what happens in practice is that many companies on the market look at these forecast models and say, aha, okay, for the delivery, let's say in three hours at 1 p.m. we have just had a deterioration in the forecast, so there is a little less wind power than we thought just a moment ago. And what happens immediately is that companies implement this information via buy orders on the intraday market.

In other words, they say we want to err on the side of caution and have a little more electricity rather than too little, because the situation has become tighter. They then buy on the intraday market, driving up the intraday price at that moment, and somewhere else in Germany or abroad a power plant, battery or other flexibility reacts to this higher price and produces more electricity or makes more electricity available. And this happens continuously every moment, in my example it's just three hours before delivery. This means that all plants and all companies and all operators that have much longer lead times for technical reasons, for process reasons, maybe it's an industrial company that can reduce the aluminium melt by 5% with three hours' lead time, but not within five minutes for whatever reason, and these companies can then react to such intraday price jumps.

In other words, the market continuously absorbs and processes the continuous inflow of information into a price signal and thus enables the optimal deployment of assets. So with five hours' notice, I can deploy assets that take five hours to start. If the information only becomes known two hours before delivery, because the weather models only then see a change in the meteorological situation, then the assets that have two-hour ramps or start times are still available. And that, I believe, is perhaps the most fundamental advantage of the intraday market compared to control reserve, which has to be fast for very good reasons and can only be fast.

What is the European Perspective on Proactive Balancing Group Management?

Jan Aengenvoort

You already mentioned it at the beginning or in the first third of our discussion: The European Balancing Guideline explicitly allows or even encourages so-called "active balancing". But what is the situation in practice in other European countries? You also took a look at this in your study.

Lion Hirth

We looked at six larger countries or neighboring countries of Germany, namely Belgium, the Netherlands, the UK, France, Austria and Denmark. We investigated whether it is legally and contractually permitted to optimize trading in a system-supporting manner, whether there is a price regime that contradicts or supports this. A decisive point is whether the grid operators promote an active reaction to the price by providing the necessary data promptly. In these countries, system-supporting balancing group management is generally accompanied and supported more positively. In comparison, Germany is on the restrictive side, both legally and in terms of data availability.

Jan Aengenvoort

This leads to an important question. How do I find out in Germany whether I will earn money or be subject to penalties if I overshoot my balancing group in a particular quarter of an hour?

Lion Hirth

To know this, I would need the physical system balance in order to estimate whether the system is in short supply or not. This information is not available in real time in Germany. The grid operators do not provide it. In other countries, such information is already available in real time. In Germany, we have to rely on the so-called Netzampel, which is published with a delay and in aggregated form. There are many other data sources, but the exact information is missing. There is also the problem that information on control reserve calls shows price jumps on the market shortly after publication. This indicates that market participants are using this information, which raises concerns about fair trading practices.

Jan Aengenvoort

How do you think a level playing field could be achieved?

Lion Hirth

It could be handled in the same way as in the UK, where all control reserve calls are published immediately to ensure that everyone has the same information. Or even better, publish the system balance live to reduce uncertainty. But this is problematic for those who do not want the market to react to such information. The discussion about this is also taking place within the grid operators, and the current solution in Germany is a limited publication of the system balance via the grid traffic light, the Netzampel.

Jan Aengenvoort

After all these practical discussions, how do you see the topic in five years' time?

Lion Hirth

I have been predicting for 15 years that we would soon have a smooth market solution, similar to that in Benelux or the UK. However, this has not happened in the last five years. The future depends on what direction is decided by the players, especially the transmission system operators and the Federal Network Agency. The discussion can go in different directions and I hope that our study can help to objectify the discussion and find solutions to take advantage of the benefits while addressing concerns at the same time.

Jan Aengenvoort

Dear Lion, thank you very much for this interview.